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Duration of sovereign debt renegotiation

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  • Bai, Yan
  • Zhang, Jing

Abstract

In the period since 1990, sovereign debt renegotiations take an average of five years for bank loans but only one year for bonds. We provide an explanation for this finding by highlighting one key difference between bank loans and bonds: bank loans are rarely traded, while bonds are heavily traded on the secondary market. In our theory, the secondary market plays a crucial information revelation role in shortening renegotiations. Consider a dynamic bargaining game with incomplete information between a government and creditors. The creditors' reservation value is private information, and the government knows only its distribution. Delays in reaching agreements arise in equilibrium because the government uses costly delays to screen the creditors' reservation value. When the creditors trade on the secondary market, the market price conveys information about their reservation value, which lessens the information friction and reduces the renegotiation duration. We find that the secondary market tends to increase the renegotiation payoff of the government but decrease that of the creditors while increasing the total payoff. We then embed these renegotiation outcomes in a simple sovereign debt model to analyze the ex ante welfare implications. The secondary market has the potential to increase the government ex ante welfare when the information friction is severe.

Suggested Citation

  • Bai, Yan & Zhang, Jing, 2012. "Duration of sovereign debt renegotiation," Journal of International Economics, Elsevier, vol. 86(2), pages 252-268.
  • Handle: RePEc:eee:inecon:v:86:y:2012:i:2:p:252-268
    DOI: 10.1016/j.jinteco.2011.08.007
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    More about this item

    Keywords

    Sovereign debt restructuring; Secondary debt markets; Dynamic bargaining; Incomplete information;
    All these keywords.

    JEL classification:

    • F02 - International Economics - - General - - - International Economic Order and Integration
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F51 - International Economics - - International Relations, National Security, and International Political Economy - - - International Conflicts; Negotiations; Sanctions

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